Or should there be a single central supervisor of trading in European securities, and perhaps of banking and insurance as well Current practice points to the first answer.
In this case, the results show that there will be an increase in the (cheaper) effort of the local supervisor that will compensate the reduction in the effort of the central supervisor, so hierarchical supervision is more likely to dominate.
18 That is, they are both downward sloping (strategic substitutes), and the slope of the reaction function of the local supervisor is (in absolute value) lower than that of the central supervisor, so the Nash equilibrium is stable.
This paper presents a model in which a central and a local supervisor contribute their efforts to obtain information on the solvency of a local bank, which is then used by the central supervisor to decide on its early liquidation.
A two-tiered supervisory model was used in India where central supervisors visited 10% of clinics quarterly to implement a quality monitoring tool and made recommendations for improvement to be followed up by the state supervisors who were meant to make regular visits (85).
The intuition is that putting the central supervisor in a situation of overload forces the local supervisor to increase its (cheaper) effort in a way that compensates the reduction in the effort of the central supervisor.5.
By the definition of Nash equilibrium, the indifference curve of the central supervisor at the point ((e_{c}^,e_{l}^)) is tangent to the horizontal line ( e_{l}=e_{l}^.) But since the reaction function of the local supervisor is downward sloping, reducing the effort of the central supervisor increases its payoff.
Hence, the commitment to reduce the effort of the central supervisor in the hierarchical supervision setup is welfare improving.
A second extension shows that limiting the size of the central supervisor in the hierarchical supervision setup is welfare improving.
The question is whether this argument also applies when we replace the indifference curve of the central supervisor by the social indifference curves.
In this setup, it would be reasonable to assume that the cost of effort is higher for the central supervisor than for the local supervisor, an assumption that may be justified by reference to geographical as well as cultural distance between the central supervisor and the local bank.
